COLLEGE SAVINGS 101

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529 E-ditorials

I feel like the kid who judiciously selected only three items to put on his birthday wish list, and found that all three wishes were granted. Last year I compiled my list, in the form of 529 E-ditorials 00-19 (The 3 Stupid Rules of 529) and 00-20 (The Number One Target). The problems I found with 529 plans were, in order:

#1: Earnings withdrawn for qualifying college expenses were subject to income tax.
#2: Account owners were prohibited from moving their money from one investment option to another.
#3: A tax-free rollover from one 529 plan to another required a change in beneficiaries.

The recently-enacted tax law took care of #1 and #3. As most 529 followers know by now, qualified withdrawals from a 529 plan after this year (and until 2010) are free from federal income tax. Furthermore, account owners will be permitted to make a same-beneficiary rollover to another 529 plan once every 12 months without triggering federal tax or penalty. (Be sure to check state-specific rules regarding rollovers.)

That change to the rollover rule created an opportunity to get around #2 regarding investment direction. If you want to replace your current investment, simply find another 529 plan with the investment option you prefer, and make the same-beneficiary rollover to the program with that option.

But now it's even better. Recognizing that families may indeed have good reasons for desiring a change in investments, and realizing that they will soon have the easy loophole to affect it, the IRS has abandoned its once-strict stance against investment direction. In a notice released September 7. 2001, our friends in Washington announced a new policy. Beginning immediately, the IRS will have no problem with a 529 plan that permits its participants to switch their accounts from one investment approach to another (limited to one switch every year).

What this means is that you will not have to leave your current 529 plan if you desire to change investment options. For the 529 plans that offer different options, and decide to accommodate a change (and I'm sure most of the savings/investment plans will be glad to do so), you will just have to make the request.

We're not talking about 401(k)-type flexibility here. As mentioned above, you can make the switch just once in a calendar year. Further, the change can only be made from one "broad-based" investment strategy to another. There will be no day-trading in 529 accounts. In fact, the term "broad-based strategy" presumably means that the IRS intends to discourage 529 plans from offering menus of single mutual funds. They believe that Congress intended that states offer structured investment programs, and not just a bunch of mutual funds under a tax-free 529 "wrapper". That certainly makes sense to me.

Of course, the demise of "The 3 Stupid Rules" doesn't mean that we should stop asking for more. In fact, the new # 1 has got to be the sunset provision in the new law. Unless extended, the recent tax changes expire in 2010 and "old" # 1 and # 3 come back to haunt us. Let's hope they answer my new wish.